Financial statement analysis and interpretation

Financial Statement Analysis

Ambiguity and Deliberate Misrepresentation to the Public in the World of Financial Statement Analysis

Recent economic events -- and, to be frank, ongoing practices in the business world that are only periodically brought to light via scandal and/or the sudden collapse of a company or industry -- demand heavy scrutiny of the methods and practice of financial statement analysis. "Creative accounting" techniques have definitely exacerbated the problem and made the recent economic downturn both more extreme and more scandalous than the correction might otherwise have been. Even without creating scandal or a massive financial collapse, however, the general practice of producing and analyzing financial statements is kept purposefully arcane by those in the industry, making it difficult for average investors and government agencies to ascertain a company or industry's true financial strength (Gauthier 2004).

Outright deception and conscious misrepresentation in financial reports, as well as deliberately naive methods of analysis, play a very large role in the problem. The sub-prime mortgage crisis that precipitated (in part) the current recession and the collapse of several major international banks and other corporations could have been avoided in multiple steps along the chain of analysis and recommendation had a more skeptical view been taken of the securities these mortgages were bundled into, or had they not been touted by those who should have known better -- and would have, in moments of true honesty. But these issues do not account for the entirety of the problem. Most analysts do not benefit in the long-term from producing misleading analyses, and certainly not from the collapse and resultant mistrust of financial institutions. They do benefit, however, from keeping their methods to themselves.

By keeping the exact methods of analyzing and rating companies to themselves, analysts and the firms they work for benefit by being better prepared than all other entities for the changing economic tides. The obfuscation apparent in many financial reports has been noted in several studies, though only common sense is needed to know that the average investor -- even most educated investors -- will not be able to make any real practical knowledge away from the typical financial report or its analysis (Gauthier 2004; Bai et al. 2008). A degree in finance, economics, or another related field is often necessary simply to understand the terminology of such reports, and a lack of standard practice in reporting and analysis can lead to difficulties even for those with such an education in knowing how certain figures were derived, let what their actual implications are in the report and the company's performance (Gauthier 2004).

This type of attitude and behavior in the world of financial analysis only makes misrepresentation and incorrect reporting more possible and lucrative, and therefore more prevalent. This has been especially true in China and other Asian countries during the past several decades of economic expansion in that region of the world (Bai et al. 2008). Government stakeholders in many of these countries have benefited along with corporations in obscure and outright false financial statements and analyses as they have attracted money form foreign as well as domestic investors an enabled national growth for many Asian nations (Bai et al. 2008). These investors, on the other hand, as well as many private citizens in these countries, have suffered avoidable losses and unnecessary economic disruptions when the misleading reporting and analysis practices are brought to light and the truth is revealed (Bai et al. 2008).